Rethinking the IS in IS-LM: adapting Keynesian tools to non-Keynesian economies Part 2

The IS-LM diagram was developed as a tool for analyzing Keynesian economies-economies with sticky prices and myopic households. In Part 1 of this article, Evan Koenig showed how a graphical apparatus similar to the traditional IS-LM diagram can be used to analyze economies with a fixed capital stock and optimizing, forward-looking households. Part 2 extends the earlier analysis to an economy with capital investment. As before, an expectations-augmented variant of the IS-LM model is found to include a popular real-business-cycle model as a special case. Thus, the IS-LM diagram has wide applicability as a pedagogical device and as a framework within which to discuss policy.